According to Ed Catmull, president of movie studio Pixar, the turning point was in 1991. That was the year that the two biggest hits at the cinema relied heavily on eye-popping computer graphics - Terminator II and, in a computer-rendered ballroom scene, Walt Disney's hand-drawn feature Beauty and the Beast.

Audiences appeared ready for the first full-length computer animated film and Disney agreed to fund a movie based on Pixar's Oscar-winning short Tin Toys. Four years of hard graft later, Toy Story was released and its performance took everyone, including toymakers, by surprise. Only the luckiest kids got Buzz Lightyear dolls that Christmas. "It was totally beyond anything we ever thought. In most people's minds, including Disney's, this was just the starter film," Catmull recalls.

In a business where there is no such thing as a sure-fire hit, Pixar has since proven remarkably reliable. Toy Story 2, A Bug's Life and Monsters Inc have grossed a combined $1.7bn worldwide.

Now comes Finding Nemo, the adventures of an unfunny clown fish in search of his lost son. The film has darted nimbly through the flotsam and jetsam of vapid sequels in the US this summer to become the biggest animated film of all time. At the American box office alone, Finding Nemo has taken $336.5m, overtaking Disney favourite The Lion King.

A sharply witty film, Finding Nemo has also won critical acclaim - the US media are even talking about Oscars. It opened across Britain yesterday.

For Catmull, 58, a co-founder of Pixar and the technical brains behind the business, the success of Finding Nemo is the stunning realisation of a long-held dream. The bearded studio boss, who looks as though he might be more at home in the company of Bill Gates than in Hollywood, first had the idea of producing a feature film using computer graphics in the mid-1970s.

At school Catmull had hoped to become an animator, inspired by the Disney movies Peter Pan and Pinocchio. Deciding that he wasn't good enough he instead enrolled into a degree course in the nascent field of computer science at the university of Utah, where he stumbled into graphics. He made an animated version of his left hand, which was used in the first film to incorporate 3D computer graphics, the science fiction feature Futureworld.

Ten years out

That same year produced other notable alumni, including Jim Clark, the founder of Netscape, and John Warnock who founded Adobe. "I thought it would probably take 10 years to get to the point where we could really use computer graphics in movies," he says. "The reality is it took more like 20 years."

Disney, which has co-funded and distributed all five of the Pixar movies, is thankful for the direction his career took - its recent traditionally animated features, notably Treasure Planet and Atlantis, have flopped miserably.

The diverging fate of Pixar's computer generated films and Disney's hand-drawn efforts has even prompted speculation that the traditional art form is dead. Jeffrey Katzenberg at rival DreamWorks, smarting from the failure of his studio's latest effort, Sinbad: Legend of the Seven Seas, said recently that he would no longer produce hand-drawn movies. The announcement was significant. It was Katzenberg who had given the Disney studio new life during the 1980s with films like The Lion King.

It is an assessment that causes Catmull to bristle. Pixar, he says, is a continuing part of a grand tradition of American animation, not its death knell. "We are in a new age where the computer has come in and added a kind of vitality to animation, but we love what has gone before. It is like a continuation.

"For me one of the great tragedies is the conclusion studios have drawn about traditional animation. I believe that 2D animation could be just as vital as it ever was. I think the problem has been with the stories. If you see a bad live action film, what are the conclusions you draw? Typically it is that they made a bunch of mistakes, a bad script, wrong casting. You get into 2D and you get a few films that are not strong films. And what is the conclusion? That it's 2D? I beg to differ. It's a convenient excuse but it's just wrong."

He points to the recent masterful Japanese fantasy Spirited Away and another cartoon great, The Simpsons. "Are the Simpsons cool? They are and that is crude 2D animation."

Catmull's reverence for the greats is more than talk. In Monsters Inc, the swankiest restaurant in town is Harryhausen's. It's the kind of joke that only the nerdiest film buff would get, an homage to Ray Harryhausen, who created the monsters for classics including the Sinbad films and Jason and the Argonauts. Catmull has a signed poster on his office wall of one of Harryhausen's creations; a fierce-looking blue medusa with a serpent's tail.

After graduating, Catmull wound up at Lucasfilm during the first Star Wars trilogy, running the computer graphics department. The division was put up for sale in 1985, and a "gruesome year" later Catmull convinced Steve Jobs, recently ousted from Apple Computer, to stump up $10m.

For the next five years Pixar struggled, making commercials, selling software licences and producing short films until the deal with Disney came along. "If we had been funded by venture capitalists they would have shut us down," Catmull says. "Steve was not a VC. He was looking at what we could become."

The company floated on Wall Street shortly after the release of Toy Story and the shares have gone from $22 to $71. Jobs pumped in another $50m along the way, but the investment has paid off. He still owns 55% of the business, a stake worth around $2.2bn. Based in Emeryville, California, close to Oakland and across the bay from San Francisco, Pixar is closer to Silicon Valley than it is to Hollywood. The business is housed in a building designed to look like a cavernous old warehouse, in fact commissioned only a few years ago. The walls are exposed brick, workers zip around on scooters, there is an outdoor amphitheatre for local bands, a pool, pilates classes and cinemas.

The artists' area is like stepping into a fleshed out cartoon. Each of the animators has an individual wooden shack. One is transformed into a cowboy saloon, including swing doors - another, painted candy pink, has dismembered doll limbs "growing" in a flowerbox.

The company is working on several new projects. Next up is The Incredibles - the story of a band of undercover superheroes in suburbia. Then comes Cars, a classic car, route 66, road movie and Ratatouille, about a rat who lives in a posh restaurant.

The quality of the graphics has moved on significantly since Toy Story. "The reason we picked toys was that we could do them," Catmull says. "They are made of plastic. We were at the hairy edge of what we could do."

For Finding Nemo, the firm was able to capture the murk of the sea and the dazzling qualities of the Great Barrier Reef. The underwater scenes were researched exhaustively. Chief animators were sent on scuba diving trips, a 25-gallon fish tank was installed in the studio and videos of The Blue Planet were mandatory viewing. The result is characters that, although humanised, move with startling realism.

"Each time the tools are allowing us to put more in there and build better worlds. The lusciousness in Nemo is unlike anything in the other films. It's important to put things in there that you wouldn't even notice, that might please the experts. You never do just enough," Catmull says. The Incredibles though will be the first film to mainly feature human beings. "It is a totally different challenge. The humans in our previous films were not the strongest element."

The success of Finding Nemo has strengthened Pixar's hand in talks with Disney to renegotiate its distribution deal. Under the existing arrangement, the two companies share profits after Disney has taken a 12.5% cut. Pixar has also been talking to rival studios. Last year, Pixar made $90m but the potential is to earn far more. The company is debt free and has $500m in the bank.

Historic

"We're talking with Disney. If it doesn't work out we have other alternatives," Catmull says. "But we've had a great relationship with Disney. There's been nothing like this in Hollywood history." Other studios, including Sony and Dreamworks, are rushing to get computer-animated movies into cinemas. Disney is producing its own versions of The Snow Queen and Rapunzel. Even IBM wants in.

Catmull has forecast an impending "train wreck" akin to the boom and bust of traditional animation that began in the mid-1980s. He maintains that although the freshness of the graphics has helped to make Pixar movies popular, the key has been the quality of the story telling.

At Pixar, the aim is to ramp up production to one film a year, but no further. "In the corporations there is certainly the mentality of playing the numbers. If you put out 20 films you hope that a number are successful. It's like human reproduction versus frog reproduction. Frogs produce thousands and hope a few succeed. Humans don't produce many babies but put a lot of energy into them, which is kind of where we are. They still don't always succeed but you try a lot harder."